Company Town | THE BIZ / CHUCK PHILIPS

Record Execs Ponder Join-'Em Venture With Chinese CD Pirates

That's the consensus among the heads of the world's six major record corporations, who have failed so far in their efforts to eradicate piracy in China, where production of high-quality, illegally copied compact discs accounts for an estimated $300 million in lost sales per year.

Convinced that the Chinese government has done little to enforce intellectual property laws, record executives are exploring the possibility of going into business with the pirates themselves.

Indeed, the big six have considered everything from launching Chinese joint ventures to paying the pirates millions of dollars a year simply to stop producing illegally copied CDs. The hope is that by aligning themselves with the counterfeiters in some way, music companies will eventually be able to convert the renegade facilities into legitimate factories.

Although there is no formal plan on the table, last week a representative for the record companies held preliminary talks in China with intermediaries for the pirates. That encounter followed a meeting four months ago between Chinese officials and Sen. Dianne Feinstein (D-Calif.), who presented a tamer joint venture plan to curb piracy.

Under the industry's latest proposal, the record companies would invest substantial amounts of money in the manufacturing plants or purchase the pirates' equipment outright. In addition, the companies would pay the counterfeiters an annual sum equivalent to their collective earnings--which last year is believed to have topped $80 million.

The arrangement would function similar to a government subsidy program under which the pirates would receive the fixed annual payment even if no CDs were produced at the plants. Executives say the record companies are prepared to commit resources to this plan for the next five years as long as the Chinese government vows to ban piracy and open the market to recordings by foreign artists.

"I know it sounds ridiculous to pay pirates to not manufacture illegal products, but frankly, everything else we've tried so far has failed," said one record executive, who spoke on the condition that he would not be identified.

"The arrangement would operate kind of like a U.S. agricultural program," the executive said. "It would give the counterfeiters a financial incentive to allow a legitimate market to develop. But we can't fix this problem by ourselves. If the record companies are prepared to stick their necks out like this, the Chinese leaders need to lay down the law."

There are at least two dozen CD plants operating in China that have an annual production capacity of 150 million units. That's more than 20 times the current demand for compact discs in China, according to the Recording Industry Assn. of America, a Washington trade group that represents the world's six largest record corporations: Warner Music, Sony, PolyGram, Bertelsmann, EMI Music and MCA.

The trade group says Chinese counterfeiters last year pumped out more than 80 million compact discs--90% of which are believed to have been exported and sold for about $1 apiece on the black market in Southeast Asia, Russia and Latin America. The piracy dispute is the center of a U.S.-China trade rift that could lead to massive tariffs on each other's products.

Executives believe that the subsidy program would not only help record companies to infiltrate the Chinese market, it would also stop tens of millions of counterfeit CDs from showing up in other regions around the world where legitimate markets already exist.

The ultimate goal, they say, is to remove much of the equipment used to manufacture pirate CDs from production. Still, the record companies hope to build joint ventures with some Chinese entrepreneurs that would record and manufacture indigenous music as well as distribute international recordings.

The record companies succeeded in conquering piracy and penetrating the Indonesian market during the mid-1980s with a similar joint venture approach. While no subsidies were paid to Indonesian pirates, the companies did compensate manufacturers with lucrative licensing deals and eventually converted facilities once used to produce hundreds of thousands of illegally copied cassette tapes into legal factories.

The piracy situation in Indonesia, however, did not turn around until government officials got serious about stamping out piracy--something record executives doubt Chinese leaders are ready to do.

Washington has repeatedly pressured the Chinese to shut down plants suspected of counterfeiting, but only seven out of the alleged 34 culprits have been closed. And though China promised not to issue any more licenses to manufacture CDs, six new plants have sprung up in the last year, the record trade group says.

The Chinese have also ignored requests to require manufacturers to stamp recordings with an industry-approved source identification code that allows tracking of legitimate products.

Even if the record companies did enter into partnership deals with Chinese manufacturers, what's to stop the pirates from opening new plants elsewhere?

Feinstein says the record companies need a strong commitment from the Chinese government to root out piracy before any real progress can be made in the war on piracy.

"If the Chinese leaders truly expect to gain access to the world market, they must start playing by the rules that everybody else obeys," Feinstein says. "Piracy of intellectual property has the potential to destroy this industry. And it's a huge problem in China.

"I'm afraid this partnership proposal is probably our most realistic option at this point. I think that the Chinese leaders understand what has to be done. Now, it's up to them to. Like Nike said, 'Just do it!' "